Then in October 1996, Molten's stock collapsed, losing nearly half its value in one day. "A lot of people were shocked; every single employee had options," Brodbine Ghoneim says. In fact, as she recalls, the management was already backpedaling. "When I first started, the option packages were very generous...but [in early 1996] they dramatically cut back."
Still, she adds, the management's message to the employees was clear: "They told us that our options definitely had value. They said, 'This is additional compensation because it's going to pay off someday." After the stock tanked, Brodbine Ghoneim recalls, "then they [management] came around and said, 'You should never count on the stock market."
Brodbine Ghoneim, who left the company in mid-1997, had envisioned using the payoff from her options to take a year off for travel. She even lost $15,000 investing in Molten Metal stock and allows that after the shares collapsed, "it was a real struggle working for a start-up."
Stock options were once bit players in the drama of capitalism, first intended back in the 1940s and 1950s as bonuses for key executives who could truly influence a company's fortunes. There has been a sea change since then. Amid the restructuring of the 1980s, many top executives took options in lieu of salary, reaping huge windfalls--and negative publicity--as American industry resurged. Small wonder, then, that others would want to hop onto the gravy train.
Robb Kundtz is a Silicon Valley headhunter who specializes in placing mid- and upper-level employees. He says that despite near-zero unemployment in the valley, his business is strong because the fortunes of local companies can shift so quickly. There are always good people bailing out of bad companies. He likens stock-option roulette, Silicon Valley-style, to "teenage sex. You're in and out in no time. You join a start-up, get your options, ride them through the IPO, and sell your shares as soon as you can at Schwab because there are no insider-trading prohibitions. Then you're ready to start looking at the want ads again."
As Kundtz's terminology suggests, options have not-so-subtly altered the rules of the company-building game. In the entrepreneurial world of the '80s, people got rich through logical means: starting companies, working hard, and hoping their efforts would build value. People like Steve Jobs, Bill Gates, and Michael Dell did so, becoming cultural heroes and creating value along the way.
Now it seems that the mind-set has shifted. Join the right company, hitch your wagon to the star of the next Jobs, Gates, or Dell, and the payoff is yours. Getting rich used to first require the creation of wealth. Now it seems possible--via options--that getting rich can be disconnected from that process, not unlike waking up one morning to find yourself holding the right lottery ticket.
Options owe much of their current vogue to an event that exists apart from the fortunes of any one particular company--a powerful and long-lived bull market. The surging prosperity it has conferred has created an expectation that share prices will continue to rise and thus options will keep paying off. And the urge--the need, even--to use them, notably among small and fast-growing companies, is greater than ever since new technologies now mature so quickly. "The time frame from start-up to IPO recently has been collapsed from five years to a year and a half," says compensation expert Scott Spector. That gives more people the opportunity to join a start-up, cash out--and try again. At the same time, says Spector, "companies are out there looking for the same few good people. They have to increase the price they're willing to pay." How that's done is simple: offer more options than the competition does.
The aggressive use of options in the start-up arena is a key concern of people like Mark Edwards of iQuantic, which structures compensation packages for high-tech companies. "These things are like candy," he says. Edwards adds that while the typical Fortune 500 company grants options equal to about 1.25% of its outstanding shares each year, the number for the typical high-technology company is 3.5%--almost three times greater. Edwards labels that number the "burn rate." It signals how much of the company is being transferred from investors to employees each year. Software and Internet companies, desperate to get to market even faster than other high-tech companies, have median burn rates of 5% and 8%, respectively. Says Edwards, "A lot of these companies don't have the discipline to think about options the way they would think about real money."
Now a commodity, options have long since become diverted from their original purpose of rewarding a cadre of managers for a job well done. While they can reward hardworking employees, options also smack of financial and accounting gimmickry that could someday collapse a company's equity like a house of cards.
Companies use options as a portion of employees' compensation, so one would assume those options are of demonstrable value. But virtually all companies deem them worthless on their books: current accounting rules do not require that companies show options as an expense. Companies granting large numbers of options thus show a fatter bottom line than they would if those options had been listed as an expense. For now, in valuing stocks, the investment community has tended to ignore the drag on earnings that a more realistic valuing of options would produce. If sentiment were ever to shift and require a more conservative accounting treatment of options, corporate earnings would suddenly fall, likely taking share prices with them.
